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Fair Pay, Fair Play: Aligning Executive Performance and Pay ReviewRobin Ferracone hits the right buttons in her new volume when she describes how to develop of an "alignment" report that can be used by boards and shareowners to ensure executive pay will be judged as "fair." She also interviewed the right people to work in a reasonable degree of wisdom from the perspective of shareowners. However, she falls short in glossing over high executive pay as a potential problem, a "myth."
That's understandable, given that she is a pay consultant. Shouting out that most CEOs are overpaid isn't likely to win clients, since most compensation committee members still look to CEOs and other incumbent directors, not shareowners, to hold them accountable... although that may be changing within a few years due to "proxy access." The book is clearly aimed at compensation committees but shareowners will also find the book useful, once they get past some of the contradictions in Ferracone's pseudo-sociology.
Warren Buffett, who doesn't use compensation committees or consultants at Berkshire Hathaway thinks the best way to effect irresponsible board members and overpaid CEOs is to embarrass them. Nell Minow advises that stories on overcompensated CEOs loudly name all members of the compensation committee.
In contrast, Ferracone hopes that "solid and consistent analysis, not embarrassment" using her "Alignment Model" will lead corporations to "self-monitor and adjust their executive pay practices, and that voluntary reform will obviate the need for additional government intervention and allow government to go back to helping solve other problems in our society, such as issues in education and the environment." Yes, and if companies would just take the necessary steps voluntarily, governments won't have to mandate measures to address global climate change. Don't count on it.
Investors have seen their 401(k) plans reduced to 200½(k) plans. Yet, according to Ferracone, "The notion that America's wealthy people have become wealthier by virtue of seizing the wealth from others instead of creating it is just simply misguided logic."
Due to huge tax cuts, the rich now bring home the largest proportion of income since the 1920s. One out of seven Americans lives below the poverty line, while the top 2% fight to retain Bush tax cuts amounting to $700 billion over 10 years. Upward mobility in the USA is now lower than in developed economies. The only industrialized democracy with a higher concentration of wealth in the top 10% than the United States is Switzerland.
Ferracone focuses her pitch at helping boards find that zone of acceptability, where pay is aligned with value delivered, even in a "say on pay" environment. That's positive, but I can't give her a free pass as myth buster, even though her actual discussions on how to pay for performance are on target.
According to Ferracone, the vast majority of CEOs are not overpaid. Their compensation, adjusted for company size, industry, performance and inflation, has been virtually flat over the last 15 years, only increasing 1.6 times. Productivity gains alone account for all but $400,000 of the increase.
Investors agree. "About 75% of the investors surveyed by the Center On Executive Compensation in 2008 said that they had no real concerns about the levels of executive compensation in the United States." Who are the members of the Center? They are the chief human resource officers of 300 of the large companies. They work for the CEOs! Who were the investors surveyed? They were the top twenty-five institutional U.S. equity investors. Many, like Goldman Sachs, JP Morgan, and Morgan Stanley were the same "investors" who took the financial services sector from 20% of the economy to 40% before the crash, through bets on synthetic derivatives and other nonproductive "investments."
Even after driving the world economy to the abyss and being bailed out, the CEOs of many of these large investment firms still got huge bonuses. However, ask beneficial owners if CEOs are overpaid; you'll get a different response. They didn't put "say on pay" and a requirement to report pay ratios into the Dodd-Frank bill because 75% of the biggest institutional investors surveyed had no concerns. They it because beneficial owners and average Americans are rightfully outraged.
Unfortunately, the American Dream and the personal aspirations of too many CEOs are built around the trinity of wealth, power and fame. These superficial values have become too embedded in the American consciousness. As we strive to resolve the financial crisis, we would do well to examine the need for a constructive shift in values that look to making a contribution to a better world... and that certainly should include well run companies.
Ferracone contends people are angry because a small percentage of companies have distributed excessive pay packages, which she rather arbitrarily defines as companies paying at the 95th percentile or higher... coupled with low performance. Does that mean those who weren't outliers earned their pay?
No, not even according to Ferracone. Many companies say that they align pay with performance, but most don't know whether, in fact, they've achieved alignment. Only 8% of variation in "Performance-Adjusted Compensation" (her trade marked version of compensation after performance happens) is explained by variations in performance, defined as Total Shareholder Return; on the other hand, 30% of variations in Performance-Adjusted Compensation is explained by differences in company size, 11% is explained by industry, and 51% is unexplained. With only 8% explained by performance, how can Ferracone argue the vast majority of CEOs are not overpaid?
In a study Ferracone herself conducted, she found the vast majority of board directors and executives feel as though greater government intervention will not only NOT solve the Alignment issue, but could make matters worse. Is this supposed to be a revelation? Of course they don't want government intervention.
Ferracone does offer some degree of balance in her Epilogue. She notes, "executive compensation should mostly be a matter that is between shareholders and the executives they employ." Government "needs to make sure shareholders have the rights they need to appropriately influence the companies in which they are invested."
Unfortunately, the first right she goes on to mention is the ability to buy and sell shares in a level exchange process. While that's important, the "Wall Street Walk" encourages poor pay alignment, since if the investors who are unsatisfied walk away the more passive investors who are left are unlikely to take action regarding pay abuses.
She adds that shareowners "need to be in a position to elect board directors and vote on key proposals that affect their equity." Good, but I would have felt better if she had inserted the word "nominate" with regard to selecting directors.
Ferracone's firm, Farient Advisors LLC, is one of a growing number of pay advisers that sprang up to meet the needs of compensation committees that don't want to be seen as conflicted by hiring the same firm that simultaneously works for management. That's certainly a step in the right direction, as is Ferracone's substantive discussion on how to align pay and performance. If shareowners, compensation committees and CEOs converge their dialogue around her Performance-Adjusted Compensation that would be another good move.
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